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Conduent, Inc.

CNDT: NYSE

Conduent, Inc. (CNDT) is a business process outsourcing company that spun-out of Xerox in December 2016. Conduent works with both public and private sector by managing digital interactions between its clients and their end users at massive scales. For example, Conduent manages the digital transactions that happen when commuters drive through automatic tolls, which appear to be replacing traditional toll booths at high rates.[1]

Investment thesis

Xerox acquired the Conduent assets in 2009 through its acquisition of Affiliated Computer Services (ACS).[2] We felt that the business was run inefficiently under Xerox ownership as sales stagnated and margins fell. Our hunch was that new management could return the company to top line growth and its previous mid-teens level margin.

Confirmation through research

ACS grew sales at a 12.8% compounded rate from 2000 through 2009 and then, under Xerox, went flat for eight years while EBITDA margins dropped from 16% to 10%.[3] In our discussions with management, we discovered that the company is engaged in negative free cash flow contracts. By exiting these alone, we believe that margins can creep back closer to that mid-teens range. Further margin expansion will be driven by portfolio focus, improved productivity and strategic cost transformation. [4]

Conduent has a leading position the $260B business process outsourcing (BPO) market, which is growing 6% annually. [5] It has a diverse client base and a recurring revenue model with a 98% renewal rate. [6] By investing in the sales force, pursuing larger deals and driving cross-sell, we believe that this new management team can get top line growing at least in line with the industry. The new CEO, Ashok Vemuri, has similar experience turning around iGate, where the stock price doubled during his two years there, ending in a sale to Capgemini. [7]

Variant Perception

Given Conduent’s past performance as an independent company, we felt confident that under Vemuri’s management, it could return to growth and its original margin profile. We think that Conduent is undervalued here and that the stock price will double as top line and margin efforts are realized.